When it comes to investment, understanding your risk tolerance is an important step to selecting the right investment for your portfolio. ‘Risk tolerance’ refers to the amount of risk you are willing to take when it comes to investing.
Simply put, the higher your tolerance, the riskier your investment style. A lower tolerance means trading off a certain level of investment for a more predictable, smother investment journey over time. But how do you determine your risk tolerance score? Start with the following factors.
Factors that will influence your risk tolerance
1. Ability to ride the storm
You need to consider your portfolio’s ability to ride out the bad times when it comes to market returns. Is your portfolio diversified enough to handle less-than-expected returns in a certain sector? Do you have enough savings or regular income that you are not depending on certain investments for your sole income? How is your plan structured to handle the bad times so that you can get through to the good? With a long-term financial plan in mind, you need to know what losses you can handle and how.
2. Working status
This ties into your income stream. Your working situation (and related considerations like your age, any parenting responsibilities, and planned retirement age) are significant considerations when it comes to your investment plan and approach to risk. The younger you are and the more stable a career (and income) you have, the more likely it is that you can handle more risk than someone who will soon not be working.
3. Time horizon
Time is a crucial factor in investment planning. It’s important to determine how soon in the future you will need the money you’re investing today. The shorter your time horizon, the more conservative you will probably be with your investment. For example, stocks that are volatile in the short term are probably not a good choice for investors who are looking to access their money sooner rather than later.
4. Personal reaction
Investment management is a strategic financial practice which requires experience and expertise to ensure the best possible outcome. However, when it comes to managing money, we cannot deny the human factor. And it’s important to understand our reactions to daily risk (and how that links to our feelings about managing our money) so that we can red flag any behaviours or beliefs that might negatively impact on our investment goals. Do you tend to rush headlong into potentially exciting opportunities resulting in impulsive financial decisions? Are you overly cautious with your wealth and never make a move even though to might end up being worthwhile? Your attitude goes a long way to determining what kind of investor you are and will be in the future.
Do you know your risk tolerance score? Speak to an independent financial adviser to find out exactly how you respond to your investment risk and how your portfolio should be responding to it. At TRG, our investment experts understand how best to structure an investment plan to work in line with our clients’ financial needs and goals.